How Leverage Inside Your IRA Triggers a Hidden Tax
Many investors are attracted to the flexibility a Self-Directed IRA provides. The ability to invest in real estate, use leverage, and pursue opportunities beyond traditional stocks and bonds can open the door to greater purchasing power. However, David and Tom Moore, co-founders of IRA Advantage and Equity Advantage 1031 Exchange, caution that borrowing inside an IRA can create tax consequences that many investors do not expect.
One of the most common misconceptions they encounter is the belief that everything inside a Self-Directed IRA is automatically tax deferred or tax free. While that is often true, the rules can change when borrowed money becomes part of the investment.
How a Non-Recourse Loan Changes IRA Tax Treatment
David and Tom frequently work with investors who use non-recourse loans to increase what they can purchase inside a Self-Directed IRA. Leverage can be a powerful tool, but it also changes how the investment is treated for tax purposes.
When a Self-Directed IRA uses a non-recourse loan to acquire real estate, the purchase is funded by two different sources: qualified IRA funds and borrowed money. Unfortunately, those two sources of money are not treated the same way for tax purposes.
The portion funded by IRA assets generally receives the tax-deferred treatment investors expect from a retirement account. The borrowed portion is different because those funds do not belong to the IRA itself. As a result, part of the income generated by the investment may become taxable.
David and Tom often emphasize that many investors focus on the opportunities leverage creates. Borrowing allows an IRA to purchase a larger property than it could otherwise afford with cash alone. What investors sometimes overlook is that leverage can also create taxation inside the account.
An EUBIT Tax Example
David and Tom use a simple example to help investors understand how this works in practice.
If a property is purchased with 50% IRA funds and 50% borrowed money, taxes could apply to essentially half of the property’s net operating income.
The exact percentage depends on how much leverage is involved, but the principle remains the same. Once borrowed money becomes part of the transaction, a portion of the income may become taxable.
That often surprises investors who assume all income generated inside an IRA receives identical tax treatment. Leverage changes the equation.
Why the EUBIT Tax Actually Belongs to the IRA
One of the most common misunderstandings surrounding EUBIT involves who actually owes the tax.
When investors hear that leverage can trigger taxation, they often assume they will personally receive a tax bill. David and Tom explain that the tax belongs to the IRA, not to the individual account holder.
That distinction is important.
The tax liability remains within the retirement account and does not become a personal tax obligation simply because the IRA used borrowed funds. Depending on how the account is structured, the EUBIT tax may be paid by the IRA itself or by an IRA LLC.
Understanding that structure helps investors evaluate the true impact of leverage and avoid confusion about personal liability.
Investors interested in learning more about retirement account structures and investment strategies can explore additional educational resources available through Equity Advantage.
Weighing the Pros and Cons of Leverage
David and Tom do not view leverage as inherently good or bad. Instead, they encourage investors to understand both the benefits and the tradeoffs before moving forward.
Borrowing money can dramatically increase what a Self-Directed IRA is able to invest in, creating opportunities that may not otherwise be available. At the same time, leverage can introduce tax consequences that many investors do not anticipate.
Taking the time to understand how borrowed money affects the tax treatment of an investment can help investors determine whether a non-recourse loan aligns with their goals and overall retirement strategy.
If you are considering using a non-recourse loan inside your Self-Directed IRA and want to understand how leverage may affect your taxes, contact Equity Advantage to discuss your options with an experienced professional.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031.
Frequently Asked Questions
Can a Self-Directed IRA use a non-recourse loan to buy real estate?
Yes. A Self-Directed IRA can use a non-recourse loan to purchase investment real estate. Unlike a traditional loan, a non-recourse lender can only pursue the property itself if the loan defaults and cannot seek repayment from the IRA owner personally. This allows retirement accounts to use leverage while complying with IRA rules.
What is EUBIT and why does leverage trigger it?
EUBIT, or Exempt Unrelated Business Income Tax, can apply when a Self-Directed IRA uses borrowed money to acquire an investment. The portion of the property financed with debt may generate taxable income, even though the IRA itself generally enjoys tax-deferred or tax-free treatment. The amount subject to tax depends on the percentage of the investment funded by borrowed money.
Who pays the EUBIT tax on a leveraged IRA investment?
The tax is generally paid by the retirement account, not the individual IRA owner. Depending on how the investment is structured, the tax may be paid directly by the IRA or by an IRA LLC owned by the IRA. Investors do not typically report the tax as personal income simply because their retirement account used leverage.
